From Hindustan Unilever to Britannia, FMCG stock rally skates on thin ice

Sector could run out of steam, given sharp slowdown in the industry revenue growth

Leading consumer goods companies, including Hindustan Unilever, ITC, Nestlé, Britannia Industries, and Dabur, have exhibited remarkable performance on the stock market in recent months. Over the past year, the National Stock Exchange Nifty FMCG Index, which tracks the market capitalisation of the top 15 companies in the fast-moving consumer goods (FMCG) sector, has surged by 17.3 per cent. In contrast, the Nifty50, a broader market index, has witnessed an 8.8 per cent increase during the same period.

The FMCG stocks have also been rally leaders in the current calendar year. The Nifty FMCG Index is up 16.3 per cent since the start of 2023, compared to a 6.6 per cent rally in the benchmark Nifty50 during the period. The rally in FMCG stocks, however, seems to be skating on thin ice and could run out of steam, given a sharp slowdown in the industry’s revenue growth.

Historically, there is a high positive correlation between net sales and profit growth.

A slowdown in net sales in the first quarter (Q1) of 2023-24 (FY24) will soon translate into an earnings slowdown, putting pressure on FMCG company’s share price. The combined net sales of 15 consumer goods companies that are part of the Nifty FMCG Index were up just 4.1 per cent year-on-year (Y-o-Y) in the April-June quarter (Q1FY24), growing at the slowest pace in 12 quarters. By comparison, the combined net sales were up 10 per cent Y-o-Y in the January-March quarter (fourth quarter, or Q4, of 2022-23, or FY23) and up 27.1 per cent Y-o-Y in Q1FY23. Most companies in the sector, however, posted double-digit growth in net profit in Q1FY24, attributable to a sharp decline in their raw material cost. The combined net profit of FMCG companies was up 18.6 per cent Y-o-Y in Q1FY24, growing at the fastest pace in four quarters.

The combined raw material expenses for the 15 FMCG companies in Business Standard’s sample were down 4 per cent Y-o-Y in Q1FY24, compared with 3.5 per cent Y-o-Y growth in Q4FY23 and 33 per cent Y-o-Y growth in Q1FY23. The gap or the spread between Y-o-Y growth in raw material expenses and net sales at 8.1 per cent in Q1FY24 is the largest in at least three years and hints at a rationalisation in production by quite a few consumer goods companies in line with a slowdown in demand, besides a price deflation in commodities. 

The companies had last reported a Y-o-Y decline in raw material expenses in Q4 of 2019-20 (FY20) and Q1 of 2020-21 in the wake of a lockdown in the country. But it was accompanied by a similar Y-o-Y decline in companies’ net sales.

“FMCG companies delivered largely muted volume growth in Q1FY24 due to still lacklustre rural demand, although there were early signs of improvement. Commodity tailwinds supported margin expansion supporting double-digit earnings growth,” write analysts at HSBC Equity Research on their earnings review for Indian companies for Q1FY24. As a result, the raw material expenses-to-net sales ratio for FMCG companies declined to a 10-quarter low of 47.2 per cent in Q1FY24, the lowest since the October-December quarter of FY20. This resulted in the industry’s operating profit or earnings before interest, tax, depreciation, and amortisation margin rising to a 16-quarter high of 27.2 per cent of the total revenues in Q1FY24, up from 24.6 per cent a year ago.

Some equity investors, however, doubt the sustainability of the margin-led earnings growth in the industry. The FMCG index has now begun to underperform the broader market after a long gap. The Nifty FMCG Index is down 2.4 per cent in the month of August so far, against a 2.2 decline in the Nifty50.